A Health Scare for Small Businesses

Ahead of Health-Care Law, Small Firms Worry About Crossing the Crucial 50-Person Threshold

Small businesses may face penalties when the 'employer mandate' provision of the new healthcare law kicks in in 2014. The new rule requires busiesses with 50 or more employees to provide insurance. WSJ's Emily Maltby reports. Photo: Getty Images.

By

Emily Maltby

Updated Jan. 16, 2013 7:44 p.m. ET

During her two-plus years in business, Elizabeth Turley has steadily recruited new employees for her apparel company, Meesh & Mia Corp., to keep pace with its rapid growth. But this year could be different. Instead of increasing her staff, she plans to hire independent contractors for tasks that can be outsourced, such as marketing and product development.

Her reason? Meesh & Mia is on the cusp of having 50 full-time employees. If the company hits that threshold, it will have to provide health coverage that meets government standards or potentially pay a penalty.

ENLARGE

Elizabeth Turley, CEO of Meesh & Mia, plans to hire independent contractors this year because of health-insurance changes. Ms. Turley looked at fabric options at a trade show Tuesday.
Adrienne Grunwald for The Wall Street Journal

"We are poised this year to more than double or even triple business," says the 58-year-old Ms. Turley, whose Idaho-based company makes "spiritwear," or clothes with licensed college and football-team colors and logos. "And then this happened.... We have to find another way to get there."

Even though the rule doesn't go into effect until early 2014, a business could be subject to the so-called employer mandate if, during 2013, it averages 50 or more full-time equivalent employees, according to recently released regulations from the Treasury Department and the Internal Revenue Service.

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Employers have the choice to calculate their head counts by averaging the full 12 months of 2013 or a consecutive six-month period during the year. (See sidebar on B4.)

Many small-business owners haven't yet realized that the way they structure their firm in 2013 could determine their status under the law in a year's time.

The government issued the little-noticed regulatory guidance on Dec. 28. Ms. Turley says she wasn't aware of the rules until a Journal reporter informed her.

To avoid the health-care law's penalties, many employers are considering hiring only part-time employees or deliberately curbing growth so that they have no need to hire.

For Ms. Turley, that isn't an option. Meesh & Mia needs more hired help. The best solution, she believes, is to hire independent contractors, who would be able to take on certain tasks without upping her headcount.

Typically, independent contractors are less expensive for employers, who don't have to pay taxes on wages or supply benefits, as they would for their employees. Reliance on independent contractors has increased over the years, particularly in the recession, when employers sought less expensive labor.

In December 2012, 6.7% of payroll checks written by small employers went to 1099 workers, or those not considered employees of a company, according to SurePayroll, a Chicago-based payroll firm that caters to 40,000 small employers with an average of seven employees. That's roughly double the 3.5% of payroll checks that went to 1099 workers in December 2007.

The trend is expected to accelerate this year given the framework of the looming health-care law, employment analysts predict.

Ms. Turley knows that hiring independent contractors isn't always ideal. "You have less control over hours they work and how much involvement they have in other parts of the business," she says. "Employees take more pride and ownership [in the company] than contractors."

In the past, in fact, she has hired contractors but later brought them into the fold as full-time employees.

Using independent contractors has long been a sensitive issue because of how they are classified for tax purposes. In late 2011, the IRS vowed to be more vigilant in finding employers who improperly label workers as independent contractors. At the same time it launched an amnesty program for employers to voluntarily reclassify workers in exchange for a reduced payment to cover back taxes.

"If anything, [audits] will increase more" in light of the health-care law, says Monique Warren, partner at workplace law firm Jackson Lewis LLP in White Plains, N.Y. "Employers have to be real careful about calling someone an independent contractor."

Government auditors would determine whether a worker misclassification triggers the health-care law's employer mandate. That means the stakes are higher for employers, particularly those who have close to 50 full-time employees. They could have to pay back taxes in addition to potential penalties associated with the health-care law, should the revised classification push their employee headcount over the threshold.

"Some businesses may be tempted to classify someone as an independent contractor to avoid the headcount that could subject them to the [employer mandate]," says Edward Lenz, senior counsel at the American Staffing Association, an Alexandria, Va., lobbying group for temporary and contract staffing firms. "If anything, the risks of misclassifications are exacerbated by the [health-care law]."

Adding to the confusion for small firms is that an employer's view of who is an independent contractor may not align with the government's. The guidelines defining independent contractors "aren't black and white," says Ms. Warren. "To some extent, it is deliberately vague. The IRS can't... account for every different situation."

Some considerations include an employer's level of control over a worker, the permanency of the relationship and how the business pays the worker. Because the definition lacks strict parameters, employers can file a form requesting the IRS to make the determination.

"This is on the hot list for the Department of Labor and the IRS," says Penny C. Wofford, employment law attorney at Ogletree, Deakins, Nash, Smoak & Stewart, P.C. in Greenville, S.C. "It's not enough to say a worker should be 1099 status just by their work contract. That's just one factor in a test."

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